You may be here because you recently found out you are going to be audited, or perhaps you’re trying your absolute best not to be. Before we start, we’d like to make a small disclaimer. Audits do not have to be horrifying. When you understand why they are in place and what happens during the audit, you’ll realize they are more of a time-sink than anything else. Audits are tedious, sure, but you will be happy to hear they will not be the end of your business, and shouldn’t be the cause for sleepless nights.
Keep in mind, you’ll need to file your taxes in Canada once a year. The deadlines vary depending on your company structure, but regardless, the CRA will be able to go back 4 years for the audit. If they do find anything, though, they will be able to go back as far as necessary. This is why it’s super important to keep your accounts up to date from the moment you open your business, even if it’s only small.
In this article, we will go through the following:
- What is a CRA audit?
- Why am I getting audited?
- Three types of audits.
- How do I prevent an audit?
- How do I survive an audit?
- What happens if I get audited and don’t have receipts?
So, what is an audit?
When the CRA audits your business, they are basically going to conduct a full review of your accounts. That means they’ll look at your bookkeeping, and make sure everything aligns with your final accounts. Basically, they want to ensure that you are paying the right taxes. So they’ll keep a keen eye out for any under-declared income, or over-declared expenses.
If you have kept your bookkeeping up to scratch, there is really nothing to worry about. This will simply be a tedious process that can happen to anyone. Essentially, three things can happen if you get audited:
- The CRA is happy with everything they’ve found, concludes you don’t owe any money, and leaves you be.
- The CRA finds you owe them money, you’ll need to then sign a form to say you’ll pay it, and then you pay the extra amount.
- The CRA finds you owe them money, but you dispute it. If this is the route you choose, it’s super important to have a good tax lawyer and/or CPA on your side to help with this. Depending on the situation, this could reduce the amount you owe, reinstate the initial amount and force you to pay or throw out the charges entirely.
Why am I getting audited?
Audits are random, but there are certain things you can do to increase your chance of being audited. For example:
- Not reporting income that has already been reported to the CRA elsewhere (for example, on W2’s or 1099s, T4As, or T4s).
- Misclassifying your employees
- Not issuing information returns.
- Taxing large tax deductions that the CRA deem “suspicious.”
Ensure you look through and understand all of the above steps to reduce your chance of being audited.
Three types of audit
We’ve all seen audits in the movies, yet, generally speaking, audits don’t look anything like as dramatic. Most often, you’ll see one of the three following types of audits.
- Correspondence Audit – this is an audit conducted by email or mail.
- Office Audit – this audit will be conducted in a CRA office. We recommend you bring a CPA or lawyer along with you here.
- Line-by-line Audit – this is an audit where the CRA goes through each line of your tax return.
The main thing you need to focus on here is complying with the CRA, providing sufficient evidence to the questions they ask, and showing you do not have criminal intent, you will be fine.
How do I prevent an audit?
As mentioned above, there is no way to 100% avoid an audit. Having said that, there are steps you can take to reduce your chances of being audited, and make the audit process a lot smoother should you ever be audited.
- Double-check your tax return
This may seem obvious but looking through your tax return a couple of times will make sure you don’t make any errors. Hiring a good bookkeeper and accountant for this will largely reduce your chance of getting audited.
- Include all your income
It may seem enticing to not declare your side-hustle income, but the CRA will use forms likeT4As, T4s, W2, 1098 and 1099 to double-check your tax return. If they find discrepancies, this will be a huge red flag and you’ll likely hear from them about conducting an audit.
- Understand the difference between an employee and a contractor
It’s crucial to understand what taxes you need to withhold and pay for employees, and what you need to do if you hire a freelancer. If you end up paying the wrong amounts, this will raise a flag for the CRA to audit your company.
- Use the same accounting method
Make sure you choose a style of accounting (cash basis or accrual accounting) and stick to it.
- Don’t claim everything as business deductible
One of the first things the CRA will look at is your deductibles. If you have large amounts under entertainment, travel, meals etc, your chances of getting audited are much higher.
On this note, avoid claiming 100% business use of a vehicle. This is a big flag for CRA, as they know in 99.99% of cases, business owners will not have a car that is only being used for business. If you do happen to be someone who only uses their vehicle for business, make sure you keep a log of your mileage, dates, locations, and why you were going there to avoid any further questioning.
How do I survive an audit?
There are a couple of things you can do to ensure a pain-free audit if it ever does come around.
- Keep organized accounts
Hiring a bookkeeper to help with this will make your life a lot easier. When you have your accounts in order, it becomes super easy to respond to any questions the CRA may have. In some cases, you may simply be able to give them access to your accounting software.
The CRA will want to see that you have made a profit margin at some point during your business, so you do not fall into the “hobby-loss rule.” This rule essentially states that you cannot submit losses on an activity that is not deemed a business.
- Keep your personal and business expenses separate
If you are run a sole proprietorship, the rules aren’t as black and white, but it still makes sense to have a separate account that contains purely business transactions to make it easier to track everything.
If you run a LLC or an incorporation or other limited company, you, by law, must have a separate business bank account. If you do commingle expenses, you end up piercing the corporate veil which essentially means you lose your limited liability. If this happens, creditors (including the CRA) can sue you personally for money if your business is unable to afford it – not good!
On top of all of this, if you have a separate business account, it will allow for a much easier audit.
- Get help from a tax professional
It’s hard to keep on top of all the rules, especially when they change over time. Hiring a professional in the industry will ensure your books are in order. Consider Accountero, we can help you track your growth by maintaining clear, accurate, up-to-date financial statements on the cloud. With this, you’ll be well prepared should the CRA come to audit.
- Only provide the CRA with the information they ask for.
No more, no less. This will help keep things streamlined and keep the attention of the auditor on the work they are asking about, instead of complicating things with other areas of the business. You want to keep things as easy as possible for the auditor, whether that’s a comfortable space in your office or prompt, polite conversations over the telephone or email.
If you feel the audit has been unfair, or the outcome is not a truthful representation of your company, do not be afraid to appeal. You usually have about 30 days to rebuttal a statement of adjustment, and there is a process online to help you get through this.
What happens if I get audited and don’t have receipts?
If you don’t have receipts for your transactions, and you get audited, the process could be a lot harder. The CRA will need receipts to verify that transactions are what you say they are, and if you cannot prove this, they may make these expenses disallowable which will increase your net profit and therefore tax liability. Note that you don’t need to keep paper receipts if you have a clear digital copy.
In sum, always keep your receipts handy. Even better- have them embedded in your tax system during reconciliation.
As long as you have all of your accounts in order, and you are abiding by the rules, an audit will not be anything to worry about. If you need help with your accounts, let us know, we’re here to help.
About Accountero
Accountero is a “built for founders” financial hub for growth-focused startups. We simplify the accounting process for business owners. Get access to human-driven, tech-powered bookkeeping services, one-click access to advisors to help you save on taxes, and high-level reports to identify areas of growth potential. Talk to us today about your accounting needs.
Accountero is a tech-powered service provider offering bookkeeping, tax advisory and fractional CFO. Accountero is not a public accounting firm and does not offer services that require a public accounting practice license.